Optimizing Cash Management in the Target2-Securities platform

As regulators, market infrastructure providers and participants prepare to adapt their processes and systems to shorter settlement cycles, ensuring provision of adequate cash during settlement of securities transactions will become increasingly challenging. This paper presents the salient features of the T2S settlement optimization framework with an emphasis on technical netting and auto collateralization. It also outlines the key considerations for rationalizing the cash account models for Central Bank Money (CeBM) based settlement in T2S.

‘Cash is King’ has been the driving mantra for liquidity managers across the globe. Ensuring the right amount of liquidity at the right place at the right time is one of the primary cash management objectives of liquidity managers. Irrespective of the underlying business transaction driving the need for liquidity, an efficient liquidity management system is characterized by three fundamental elements:

  • Optimal cash account structure
  • Efficient liquidity transfer mechanism
  • Sophisticated cash forecasting tools

As regulators, market infrastructure providers and participants prepare to adapt their processes and systems to shorter settlement cycles, ensuring provision of adequate cash during settlement of securities transactions will become increasingly challenging. With the TARGET2 Securities (T2S) go-live scheduled for 2015, and memories of the credit crunch during the 2008 financial crisis still fresh, the European Union (EU) capital market participants are transforming their existing operating models, policies and procedures for cash management. The objective of transforming cash management approach is to realize the benefits of higher operational efficiency and reduced costs afforded by T2S.

T2S Settlement Optimization Framework
T2S is a technical platform for settlement of securities using CeBM. However, it also offers a comprehensive suite of liquidity management functions that increases settlement efficiency through optimized usage of liquidity available in the T2S Dedicated Cash Account (DCA). The T2S optimization framework comprises technical netting, auto-collateralization, partial settlement and a suite of settlement optimization algorithms aimed at improving settlement rates.

Technical netting, complemented by intraday credit facilities that act as additional sources of liquidity, presents opportunities to optimize the use of available resources and maximize the settlement rates. While settlement in T2S is based on the Bank of International Settlements’ (BIS) DVP model 1 (gross settlement of securities and cash), the T2S optimization algorithms leverage the technical netting concepts of BIS DVP model 3. T2S settlement process involves netting of both cash and securities while validating the net amounts against the available resources. However, to reap the benefits of technical netting, the securities and cash account link configuration in T2S must be rationalized.

Provision of intraday credit in the form of auto-collateralization offered by the Central Banks and payment banks help address the liquidity demands of securities settlement and custody related operations. T2S uses a generic optimization framework for both night and day-time settlement period and resorts first to technical netting and subsequently, if required, to intraday credit in case of lack of cash. The T2S optimization framework also includes a diversified set of sophisticated settlement optimization algorithms to maximize the volume and value of settled transactions. The optimization algorithms aim at building group(s) of transactions using technical netting principles that can be settled using the available resources.

One of the key imperatives to leverage T2S optimization techniques to ensure optimal usage of available cash resources and maximizing settlement rate is to rationalize the cash account structure for servicing of securities accounts.

Organizational requirements demand that the performance of cash operating models be assessed on a regular basis against pre-defined benchmarks for settlement efficiencies and costs savings. Harnessing the T2S optimization toolkit comprising technical netting and auto-collateralization will be the key towards achieving these objectives. The risk-reward trade-off associated with each of the available options must be analyzed prior to the implementation of the target cash operating model. The phased market-wise migration approach in T2S will ensure that the transition to the target cash operating model will not be a ‘Big Bang’, but a gradual process over a period of time. This offers ample opportunities to the banks for streamlining their models during and after the T2S migration period.

The organization’s cash operating model must align with the overall cash management strategy at all times- be it the consolidation of complex multi-vendor relationships or reorganization of cash account structures to manage client and proprietary businesses. With T2S reenergizing the EU post trade landscape and banks looking for solutions to achieve the twin objectives of minimizing funding costs and maximizing settlement rates, the T2S community is all set to experience innovative cash models based on technical netting and auto- collateralization.

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